Be Careful When Comparing Amazon to Netflix

As if Netflix (NASDAQ:NFLX[1]) didn’t have enough to worry about already[2], Amazon (NASDAQ:AMZN[3]) has gone and thrown yet another wrench into Netflix’s works.

The popular e-commerce site now offers its Amazon Prime service at a mere $7.99 per month. Amazon Prime gives subscribers access to a decent library of online-streaming movies and television shows, access to a “borrowed” e-book (one at a time), and free delivery for most physical goods ordered through the website.

If the $7.99/month price point rings a bell, that’s because it’s the monthly fee most Netflix subscribers pay for access to online digital content, and the same price Hulu — the joint venture of Comcast (NASDAQ:CMCSA[4]), Disney (NYSE:DIS[5]) and News Corp (NASDAQ:NWSA[6]) — charges for access to Hulu Plus, which also offers more and newer digital content than is available on the free version.

Of course, it took consumers about two nanoseconds to conclude that Amazon was taking dead aim at Netflix, and to a lesser degree keeping Hulu at bay. It took about three more nanoseconds for the market’s pundits to start talking about the fiscal impact Amazon’s new pricing model could have on Netflix.

And those experts may well be right. But before adopting their conclusions, investors might want to consider a couple of other, obscured details.

Details, Details

Die-hard fans of Netflix will be quick to point out that the digital content library available to Amazon Prime customers pales in comparison to Netflix’s lineup. And those die-hard fans would be right. Over the course of 2012, however, the gap between the breadth and depth of both online-streaming services has been closing.

Netflix still says it has three times the content library Amazon has. Other sources say it only has twice the amount of Amazon’s digital content. Either way, Netflix still is the top dog in the business. But, as Amazon finesses more and more studios and distributors, it’s getting tougher to pick one over the other.

It’s not just a content quality/quantity question right now, though. If it was, Netflix would win hands-down. Perhaps more important to investors is the differing subscriber trends each company is experiencing.

Although Amazon never has disclosed the headcount of Prime subscribers, some very educated guesses have been made since the service got going in 2009 and started out with roughly 2 million customers. Some say Amazon was aiming for 10 million by the end of 2012, while others say the total Prime customer base is already 13 million. Either way, the number is big, and getting bigger faster.

Meanwhile, though Netflix still is adding subscribers, it’s doing so at a much slower pace than it had been. After adding 2.95 million global subscribers in the first quarter of the year, it only added 1.85 million in the third quarter. Its DVD rental business actually lost (net) 630,000 customers in Q3. As of the last tally, Netflix has 29.4 million streaming content subscribers and 8.6 million DVD-rental service subscribers.

Just to put that in perspective, Amazon’s digital content business is half the size of Netflix’s, and Amazon.com isn’t even a dedicated digital content company — its focus still is on online retailing.

That’s where the debate takes an unexpected left turn.

Conclusion

The news of the new monthly pricing plan for Amazon Prime has polarized investors who are convinced every industry has only one viable winner and one key loser. Those investors act — and trade — accordingly.

Thing is, making an apples-to-apples comparison of the two might ultimately be a misstep.

Amazon doesn’t have to make money with its digital content business. In fact, given the company’s penchant for spending big bucks to win market share rather than turn a profit, odds are good it doesn’t make much — if any — money with Prime. It’s just as much a marketing and customer acquisition tool for its other lines of business, such as e-books, and sales of all sorts of physical goods. While at some point the online streaming content business can and should be self-supporting, Amazon has proven it doesn’t need to be in a hurry to widen the bottom line.

Netflix can’t say (or think) the same. If it’s not selling its service for at least a little more than providing that service costs the company, it can’t remain in business.

And as of the beginning of 2012, that has been the problem. Netflix swung from a huge profit of $4.26 per share in 2011 to what will most likely be a profit of only 4 cents in 2012. The forecast for a profit of 41 cents per share in 2013 isn’t much more encouraging. The problem? Content costs are just a tad less than subscription revenue, and not much is going to change that going forward; Netflix wouldn’t dare up the price from being on par with Hulu Plus and Amazon Prime.

Bottom line: If you’re only willing to own one, then AMZN is the name to own. However, that’s got little to do with the quality of Amazon’s streaming business, which is just a hair above “good enough.” To investors, the compelling aspect of Amazon Prime is what else it can do with those customers.

As of this writing, James Brumley did not hold a position in any of the aforementioned securities.